The Federal Reserve is usually a friend to presidents, keeping inflation in check and the economy humming.
But the Fed under current chair Jay Powell is beginning to cause President Biden some headaches, as it struggles to assess unusual economic developments. The Fed this week surprised nearly everybody by signaling earlier interest rate hikes than in prior forecasts. The prevailing view at the Fed is now that the central bank will raise rates twice by the end of 2023. The prior outlook, three months ago, anticipated no rate hikes in the foreseeable future.
James Bullard, president of the St. Louis Fed, thinks hikes may come sooner. He told CNBC on June 18 that he expects the Fed to raise rates as early as 2022. He also used the laden word “hawkish” to describe the Fed’s monetary policy posture, which is the opposite of the dovish policy everybody thought the Fed was practicing.
Markets got twitchy. After hitting a new record high on June 14, the S&P 500 slumped and then dove on Bullard’s remarks, ending down about 1.7% for the week. Modest interest rate hikes aren’t inherently bad, but traders used to Fed pampering may now have to adjust to a more assertive overlord.
As Yahoo Finance’s Brian Cheung points out, the Fed hasn’t actually changed policy. At the latest meeting of its rate-setting committee, the Fed left short-term rates unchanged, near 0, and said it will continue other policies meant to juice the economy. Beyond that, the first rate hikes remain two years away, under the Fed’s prevailing view.
Markets are reacting, however, to worrisome trends that Biden would be wise to pay attention to. The most important is inflation, which is now running at 4.9% on an annual basis—the highest level since a brief upward blip in 2008. If inflation becomes a trenchant problem, the Fed will have to raise rates to cool the economy and tamp prices back down. White House and Fed officials alike have been insisting the current spate of inflation is “transitory,” because of one-time factors relating to the coronavirus pandemic. But the Fed’s recalculation suggests maybe the Fed isn’t so sure about that.
“The upward revisions at this week’s [Fed] meeting were hard to square with Fed officials’ continued belief that higher inflation will prove mostly transitory,” economist Andrew Hunter of Capital Economics wrote in a June 18 analysis. “We aren’t as confident as the Fed that the supply shortages holding back production and employment will ease soon.”
Used-car prices have soared because a shortage of semiconductors has constrained new car production. Research firm Gartner thinks the semiconductor shortage will last for another year. Is that transitory or not?
Another factor contributing to inflation is the difficulty firms have hiring workers, which is forcing employers to pay more and pushing up labor costs and prices. This might sort itself out, as vaccines make workplaces safer, schools reopen, parents catch a break on child care and federal jobless benefits run out in September. Yet there could also be a prolonged dislocation of workers as the post-Covid economy settles into a new normal that isn’t clearly defined yet.
For now, Biden seems to have the wind at his back going into the 2022 midterm elections. Covid vaccines are ending the pandemic faster than many Americans expected. The economy is recovering faster and stronger than most economists predicted. Voters seem to appreciate the pandemic aid and tax breaks included in the relief bill Biden signed in March, even if they amount to overkill. Whenever the Fed does raise rates, it will probably be because the economy is strong enough to handle it.
The White House, however, may have to upgrade its messaging on inflation. Instead of saying don’t worry, it won’t last, Biden and his advisers may be wise to start acknowledging the rising gas prices are hitting drivers’ wallets. Feel the pain of wannabe home buyers priced out of the market. Show some sympathy for travelers paying $100 a day to rent a car to see their parents or kids for the first time in months. And maybe stop telling us it’s transitory until it’s over.
Rick Newman is the author of four books, including “Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman. You can also send confidential tips, and click here to get Rick’s stories by email.
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